WSJ: Some Bankruptcy Basics

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Some Bankruptcy Basics
Faced with ballooning debt, more American families are filing for
bankruptcy. Here's what you need to know.

By BRETT ARENDS

American families are now going bankrupt at the rate of 22,000 a week.

It is quickly becoming a part of American life. So far this year
nearly three-quarters of a million individuals and families have filed
for court-approved bankruptcy, according to the American Bankruptcy
Institute, a professional trade group. That included more than 88,000
last month alone. The figure by year's end may top 1.1 million.

No one likes it. And those who have lived within their means and are
repaying their debts may feel aggrieved that others get to wipe the
slate clean. But that's the reality of the credit crunch. (Note, by
the way, that many bankers who made these improvident loans got to
walk away easy, with huge bonuses, thanks to limited liability).

Three years ago, Congress tightened the rules on who could file for
bankruptcy, partly after lobbying by the banking industry. The main
effect, say some bankruptcy attorneys, was to raise the costs and red
tape.

Bankruptcy may offer you a way out of your debt nightmare. And the
process starts with a lawyer. The National Association of Consumer
Bankruptcy Attorneys will have the names of specialists in your area.
If you're thinking of filing, the main question to ask is: Chapter 7,
or Chapter 13? They are two very different types of bankruptcy.

Chapter 7 can also be called "liquidation" or a "short" bankruptcy.
You're out of money, you can't make any payments, you go through the
court system and wipe the slate clean, at least for unsecured debts
such as credit-card balances. It takes a matter of months.

Chapter 13 is a court-supervised repayment plan. It lets you keep more
assets, but can also help with some secured loans – including car
loans and mortgages – that aren't typically helped under Chapter 7.
The court will approve a plan under which you repay some of what you
owe over a period of three to five years.

"In most cases, Chapter 7 will be preferable," says Richard Nemeth, a
bankruptcy attorney in Cleveland, Ohio. "You're finished in a matter
of months. It discharges all the debt that is subject to being
cancelled."

There are a few debts it will not discharge. Among them: back taxes,
student loans, child support and alimony.

The process? You meet your attorney, and you bring past tax returns,
pay stubs, bank statements, and documents showing other assets and
debts. You go through credit counseling as part of the process. You
file with the bankruptcy court. The court should issue an automatic
stay that stops creditors from doing anything – such as harassing you
with phone calls or trying to seize assets. Within about a month you
are likely to meet a creditors' trustee to review your situation.
After this the court may wait another two months or so, to see if any
objections are filed to your petition. You also need to take a credit
education course. And then you should get an order discharging you
from most of your debts.

Some assets are exempt from Chapter 7 bankruptcy, which means you can
keep them even while turning out your pockets and saying you're broke.

The first is any qualified retirement plan. That includes an IRA or
401(k) as well as any company pension plan.

Many people, when they find themselves getting deeper and deeper into
financial difficulties, may react instinctively by cutting back on
"non-essentials" like pension contributions while they try to keep up
with payments. But under current law this is exactly the wrong thing
to do. If you are sliding deeper and deeper into the hole, you should
make sure you contribute the maximum into your 401(k) or equivalent at
work. You should also put the maximum – usually $5,000 – into your IRA
each year. If you have a non-working spouse, give them $5,000 to put
into a spousal IRA too. If you end up filing for bankruptcy, that
money should be safe from creditors. But do it as early as possible.
The court will take a very dim view of anyone deliberately socking
money into a retirement account moments before filing for bankruptcy,
as they consider it a dodge. The earlier you do it, the safer you are.

The second important asset that may be sheltered from creditors in
bankruptcy is your home. This means only your primary residence. How
much you can shelter varies from state to state. A few states – such
as Florida and Texas – have an unlimited so-called "homestead
exemption". There are, however, some rules on how long you have to
have lived there and owned the home for it to qualify. Other states
only allow you to keep a home provided you have certain amount of
equity.

Some other assets may also be sheltered, like your car and some
personal effects. The limits here also vary from state to state.

Chapter 13 bankruptcies will make more sense for others. Instead of
wiping out debts immediately, the court approves a schedule by which
you pay back at least some of your debts over a long period, often
three to five years. At the end most of the rest of your debts are
forgiven.

So why would you pick this route?

"The main reason they file for Chapter 7 is to deal with secure debts
like car loans, mortgages and the like," explains Henry Sommer, a
bankruptcy lawyer in Philadelphia, Pa. "In general, Chapter 7 doesn't
affect them. In Chapter 13 you may have a right to modify your car
loan, and you can "cure" a mortgage default – in other words, catch up
on your back payments." People should also consider Chapter 13
bankruptcy if they have property that they want to keep but which
would not be protected in Chapter 7. There are a variety of rules
about how much has to be repaid to each creditor.

As usual with the law, there are lots of loopholes, and loopholes
within loopholes. Other types of bankruptcy filing include Chapter 11,
which is common for corporations but rare and expensive for families,
and Chapter 12, which is similar to Chapter 13 but specifically
targeted for family farms. And bankruptcy lawyers sometimes talk about
a "Chapter 20" reorganization. It's just a colloquial term for first
filing a Chapter 7, to wipe out a lot of debts, and then filing a
Chapter 13. There are benefits to this two-stage process for some.

Of course filing for bankruptcy is going to hurt your credit score and
could make it harder for you to get a loan in the future. But the
effect may not be as bad as you think. Most people who end up filing
for bankruptcy already have poor credit scores. And bankruptcy, by
wiping out debts, can actually help rebuild them. "Most people can
rebuild their scores within one or two years," says Jeff Tromberg, a
bankruptcy attorney in Fort Lauderdale, Fla. "It's actually quite
common for somebody who files a chapter seven bankruptcy to rebuild
their credit scores back up to the high 600s (a reasonable rating), if
not higher, within two years."